Beyond Bounded Instrumentality in Corporate Sustainability

1

Beyond the Bounded Instrumentality in Current Corporate Sustainability Research:

Toward an Inclusive Notion of Profitability

Tobias HahnKEDGE Business School, Domaine de Luminy – BP 921, 13288 Marseille Cedex 9, France

tobias.hahn@kedgebs.com

Frank FiggeKEDGE Business School, Domaine de Luminy – BP 921, 13288 Marseille Cedex 9, France

frank.figge@kedgebs.com

Published as:Hahn, T. & Figge, F. 2011. 'Beyond the Bounded Instrumentality in Current Corporate

Sustainability Research: Toward an Inclusive Notion of Profitability.' Journal of Business Ethics,104(3), 325-45, doi: 10.1007/s10551-011-0911-0.

ABSTRACT

We argue that the majority of the current approaches in research on corporate sustainability

are inconsistent with the notion of sustainable development. By defining the notion of instrumen-

tality in the context of corporate sustainability through three conceptual principles we show that

current approaches are rooted in a bounded notion of instrumentality which establishes a

systematic a priori predominance of economic organizational outcomes over environmental and

social aspects. We propose an inclusive notion of profitability that reflects the return on all forms

of environmental, social, economic capital used by a firm. This inclusive notion of corporate

profitability helps to redefine corporate profitability as if sustainability matters in that it over-

comes the bounded instrumentality that impairs current research on corporate sustainability. We

apply this notion to different car manufacturers and develop conceptual implications for future

research on corporate sustainability.

Beyond Bounded Instrumentality in Corporate Sustainability

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Keywords: Corporate sustainability, Corporate objective function, Instrumentality, Profitability,

Car industry

Beyond Bounded Instrumentality in Corporate Sustainability

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INTRODUCTION

In the traditional view the ultimate goal of companies is to use resources efficiently and to

maximize risk-adjusted return on capital (Jensen and Meckling, 1976). It is the role of public

policy to set an adequate regulatory framework that ensures that the profit-maximizing behavior

of private firms is inline with overarching societal objectives, leaving private business with the

imperative to maximize shareholder returns while respecting legal obligations (Friedman, 1970).

This view has been challenged by many management scholars who argue that companies have a

wider responsibility that goes beyond profit maximization. In this context, the concept of

sustainable development has gained increasing attention and relevance in the last decade.

Sustainable development originates from the macroeconomic level (Hanley, 2000) and is

grounded in the three principles environmental integrity, economic prosperity, and social equity

which are commonly referred to as the three pillars of sustainability (Barbier, 1987; Elliott,

2005). The business sector has been more and more confronted with sustainable development

(Bansal, 2002, 2005; Dyllick and Hockerts, 2002; Etzion, 2007; Figge and Hahn, 2005; Gladwin

et al., 1995a; Goodall, 2008; Shrivastava, 1995; Springett, 2003; Westley and Vredenburg, 1996).

It is now generally accepted that without corporate support, society will not achieve sustainable

development, as firms represent the productive resources of the economy (Bansal, 2002).

Indeed, most of the literature on corporate sustainability, corporate social responsibility and

environmental management follows the idea that companies depend on environmental and social

resources that are scarce and thus have to be taken into account in corporate decision making

(Hart, 1995). While the debate on corporate sustainability has its roots in the field of

organizations and environment (Bansal and Gao, 2006; Etzion, 2007; Kallio and Nordberg,

2006), there is also a rich body of research that addresses social issues in management such as

Beyond Bounded Instrumentality in Corporate Sustainability

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research on corporate social responsibility (Lockett et al., 2006) and corporate social

performance (Clarkson, 1995; Mitnick, 2000). The ultimate challenge of research on corporate

sustainability, however, is the integration of the three pillars of sustainable development from a

corporate perspective (Gladwin et al., 1995a). In order to conceptualize and assess corporate

sustainability economic, environmental and social aspects have to be considered (Bansal, 2005)

and trade-offs between the three pillars (Hahn et al., 2010) have to be solved without any

systematic a priori predominance of any of the three dimensions. In this paper, we argue that

research on corporate sustainability to date does not measure up to this imperative as it

systematically subordinates environmental and social issues under economic outcomes as it is

still rooted in the conventional notion of corporate profitability and bounded instrumentality. In

our view, this is the main reason why the environmental and social dimension “remained more or

less an appendage” (Kallio and Nordberg, 2006, p. 452) to conventional management concepts.

In seeking to elaborate this argument, this paper makes three contributions. First, we contri-

bute to clarifying the ambiguous notion of corporate sustainability by defining the notion of

instrumentality in the context of corporate sustainability through three conceptual principles.

Namely, we contend that a sound conceptualization of corporate sustainability needs to explicate

its instrumental finality, provide a teleological integration of economic, environmental and social

aspects and offer corporate decision makers reliable guidance toward more sustainable business

practice. Second, we review the existing literature on corporate sustainability in the light of these

principles. We identify a systematic misconception, namely bounded instrumentality, in current

research on corporate sustainability which leads to misguiding signals for corporate practice. As

a response, and third, this research develops an inclusive notion of corporate profitability that

provides an instrumental notion of corporate sustainability that is not economically biased. By

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doing so, we readjust the notion of profitability to address all different forms of capital –

economic, environmental and social – without any systematic a priori predominance of any of

the capital forms. The practicability of the proposed inclusive notion of profitability is

demonstrated by an analysis of different car manufacturers’ sustainability performance.

Ultimately, our line of argument suggests, that there may be a systematic lopsidedness in the

research on corporate sustainability. In this paper, in order to overcome this bias we propose to

reconceptualize the fundamental notion of profitability as if sustainability matters.

BACKGROUND: SUSTAINABLE DEVELOPMENT AND THE FIRM

The Concept of Sustainable Development

In general the term sustainable development is defined as a “development that meets the needs of

the present without compromising the ability of future generations to meet their own needs”

(WCED, 1987, p. 43). Sustainable development as a societal concept is grounded in the three

principles environmental integrity, economic prosperity, and social equity. According to this

three pillar approach to be sustainable any development has to take into account not only

economic but also environmental and social scarcities.

Intergenerational equity is one of the key aspects of sustainable development. Sustainable

development therefore aims to increase or at least stabilize per capita well-being or utility over

time without leaving present or future generations worse off (Elliott, 2005; Hicks, 1946). Many

economists have modeled sustainable development using the so-called capital approach (Harte,

1995; Stern, 1997). The underlying assumption of the capital approach to sustainability is that

the development of a society depends on the capital that it has at its disposal and that the amount

of capital is limited. The constant capital rule calls for a development that leaves the capital stock

at least unchanged (Costanza and Daly, 1992; Solow, 1986). It is crucial to note in this context

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that there is not only human-made capital but also natural and social capital. There are two

fundamental positions in the interpretation of the constant capital rule: Proponents of weak

sustainability posit that all forms of capital are substitutable by each other so that any loss in one

kind of capital can be substituted by a surplus in other forms of capital (Cabeza Gutés, 1996;

Pearce and Atkinson, 1993). Critics point out that this assumption is erroneous because different

capital forms are – at least to some degree – complements and propose the concept of strong

sustainability (Daly, 1992; Farmer and Randall, 1998).

The constant capital rule – both in its weak and its strong form – does not require or prescribe

equal weights between the different forms of capital. Rather the assessment and integration of

different forms of capital must refer to the ultimate goal to which capital use should contribute

to. In other words, the assessment and integration must be teleological, i.e. follow from the

importance of a form of capital for achieving sustainable development.

Sustainable Development from the Firm Perspective

Despite the numerous attempts to stringently define sustainable development as a societal

concept there is no consensus yet on such a definition (Gladwin et al., 1995a). This holds even

more for the definition of sustainable development from the perspective of the firm (Bansal,

2005; Bansal and Gao, 2006; Dyllick and Hockerts, 2002; Kallio and Nordberg, 2006; Young

and Tilley, 2006). Whereas the label corporate sustainability is being more frequently used in

both academic and practitioner literature (Salzmann et al., 2005; Sharma and Starik, 2002), very

few authors attempt to provide a stringent and conceptually sound definition of corporate

sustainability (Bansal, 2005; Dyllick and Hockerts, 2002). However, there seems to be some

implicit pragmatic consensus that corporate sustainability refers to some composite and multi-

faceted construct that entails environmental, social and economic organizational outcomes.

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While the dust of early paradigmatic debates on the meaning of greening and the fundamental

implications of sustainable development for management research (Gladwin, 1993; Gladwin et

al., 1995a; Purser et al., 1995; Shrivastava, 1995) has settled, a more sophisticated conceptual

notion of corporate sustainability has not yet been reached.

Research in the field has been criticized for representing not much more than a slight

modification of conventional management theories (Kallio and Nordberg, 2006). Despite the

plea for a “management theory as if sustainability matters” (Gladwin et al., 1995a, p. 896) the

teleology of corporate sustainability still remains unclear. In this context, one can distinguish

between at least two fundamental perspectives: societal and organizational. If corporate

sustainability is perceived in terms of corporate contributions to sustainable development at a

societal level (Atkinson, 2000), long-term survival of the individual firm does not represent the

finality of corporate sustainability. Rather, from this perspective firms should only continue to

exist and grow if and to the degree to which they contribute to environmental integrity, economic

prosperity and social equity at the societal level. Consequently, firms that do not measure up to

this imperative should eventually cease to exist as they are detrimental to sustainable develop-

ment. However, if corporate sustainability is understood as the sustainable development of the

firm as an individual organization, long-term firm survival and prosperity represents an end in

itself. From this perspective environmental and social aspects represent scarcities that are

instrumental to sustained organizational prosperity. In this case, societal sustainable development

thus only enters the equation if and to the degree that environmental and social aspects constitute

a constraint or an opportunity for business success.

Corporate Sustainability and Instrumentality

This brings up the question of instrumentality. Sustainable development is a normative and

Beyond Bounded Instrumentality in Corporate Sustainability

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paradigmatic but anthropocentric construct in that it favors “a safe, healthy, high quality of life

for current and future generations” (U.S. President's Council on Sustainable Development, 1994,

p. 1) and explicitly refers to human needs (WCED, 1987). Thus unlike ecocentric notions and

deep green views, sustainable development is per definition an instrumental concept that is

meant to serve long-term human well-being. However, it acknowledges and incorporates the in-

trinsic value of ecological and social systems that need to be preserved in order to achieve such a

development. In other words and unlike the technocentric view, sustainable development posits

that there should not be any a priori economic predominance in the conception of corporate

sustainability.

However, the question of instrumentality is more complex as sustainable development is a

multifaceted construct. This becomes particularly evident if we fall back on the capital approach

to sustainability and apply it to the corporate level (Reinhardt, 2000b). Proponents of the capital

approach posit that different kinds of capital are necessary for achieving sustainable development

and that these are – at least to a certain degree – complements as defined by the constant capital

rule (Costanza and Daly, 1992; Solow, 1986). It follows that there is a clear instrumentality in

the use of a bundle of different forms of capital – namely achieving benign and robust human

development. However, and as pointed out above, an integrated assessment of this bundle of

different forms of capital should follow from a teleological viewpoint, i.e. according to the

requirements that follow from sustainability in a specific situation. Any integration of the three

different dimensions of corporate sustainability needs to take this into account.

Finally, if sustainable development is to materialize for meeting the needs of present and

future generations, any notion of corporate sustainability needs to be practical for corporate

decision making (Boron and Murray, 2004). It has been stressed that sustainable development

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will hardly be reached without the support of the private sector (Bansal, 2002). Therefore, many

scholars have called for the development of practicable measures, guidelines and management

tools that guide managers towards more sustainable corporate decision making (Gladwin et al.,

1995a; Roome, 1998).

Overall, we can identify three conceptual principles that define the notion of instrumentality

in corporate sustainability; instrumental finality, teleological integration and practicability.

Instrumental finality. Any notion of corporate sustainability should be explicit on the

ultimate goal it refers to. Does corporate sustainability refer to the longevity of the firm as an

organization by taking into account environmental and social dependencies (organizational target

level)? Or does corporate sustainability require a reference to some wider societal development

to which the firm should contribute (societal target level)? Given the still juvenile stage (Kallio

and Nordberg, 2006) and the complex nature (Bansal, 2005) of the notion of corporate sustain-

ability, we may not expect an established comprehensive and unambiguous definition and

conceptualization of corporate sustainability. However, there are clearly some core questions that

group around the question of instrumentality that may help to clarify the notoriously vague

concept of corporate sustainability.

Teleological integration. The notion of corporate sustainability takes into account the multi-

faceted nature of sustainable development that comprises environmental, social and economic

aspects. However, multidimensional conceptions of corporate sustainability have been criticized

for sending ambiguous signals to corporate decision makers and creating leeway for moral

hazard in managerial decision making (Jensen, 2001). The task of integration can thus be

specified in at least two respects. First, integration should result in a composite and/or unified

organizational outcome that reflects progress in corporate sustainability. Second and most

Beyond Bounded Instrumentality in Corporate Sustainability

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importantly, any notion of corporate sustainability needs to be conceptually able to solve trade-

offs and conflicting relations between environmental, social, and economic organizational targets

and outcomes. Any integration must thus address the relationship of the different sustainability

aspects among each others. As discussed above and in order to be compatible with the

fundamental notion of sustainable development, the integration of the different sustainability

aspects needs to follow from the ultimate sustainability objective by referring to the teleology of

corporate sustainability.

Practicability. Corporate sustainability bears a strong pragmatic dimension as it puts

forward an imperative to organizations to “apply these principles to their products, policies, and

practices in order to express sustainable development” (Bansal, 2005, p. 199). Accordingly, any

notion of corporate sustainability should inform and guide corporate decision makers towards

more sustainable business practice. In this context, many authors argue that sustainability needs

to be translated into the language and concepts that are widely accepted and understood by

managers today (Epstein and Roy, 2001, 2003; Reinhardt, 2000a). However, corporate

management of environmental and social aspects often requires novel kind of information and

data that is mostly not readily available in companies today. The principle of practicability thus

requires that any notion of corporate sustainability must not only be conceptually sound but also

viable in corporate practice.

BOUNDED INSTRUMENTALITY IN CURRENT RESEARCH ON CORPORATE

SUSTAINABILITY

In the following we address the literature on corporate sustainability in the light of these three

principles. In this context, we concentrate on conceptual approaches to corporate sustainability,

on measurement approaches and empirical studies on corporate sustainability performance. By

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appraising the existing research in the field against the principles identified above we find that

much of the existing research suffers from a bounded notion of instrumentality.

Conceptual Approaches to Corporate Sustainability

There is a growing literature on conceptual approaches to corporate sustainability that is

based on different parent disciplines. Given the inherent instrumentality of sustainable

development according to which environmental and social resources should be preserved due to

their services to human needs, we focus on instrumental approaches to corporate sustainability.

In this context, it is often argued that companies will only contribute to sustainable development

if they perceive an incentive to do so (Epstein and Roy, 2001, 2003; Husted and de Jesus Salazar,

2006; Reinhardt, 1999; Rowley and Berman, 2000). Many instrumentalists thus posit that

environmental management and corporate social responsibility pay off (Burke and Logsdon,

1996; Elkington, 1994; Salzmann et al., 2005) and try to explain when and how environmental

and/or social performance can enhance financial performance (Aragón-Correa and Rubio-López,

2007; Burke and Logsdon, 1996; Reinhardt, 1999; Rowley and Berman, 2000).

One can organize the existing approaches according to the parent concepts they are based on

(Kallio and Nordberg, 2006). Some scholars link sustainability issues to conventional notions of

corporate financial performance. Consequently, environmental and social issues are recognized

as possible drivers of corporate value and risk-adjusted free cash flows (e.g. Epstein and Young,

1998; Figge, 2005; Romero Castro and Piñeiro Chousa, 2006). Another stream of papers is based

on the resource-based view (Barney, 1991) and argues that high levels of corporate sustainability

constitute sustained competitive advantages and abnormal rents (Hart, 1995; Klassen and

Whybark, 1999; Litz, 1996; Russo and Fouts, 1997; Sharma and Vredenburg, 1998). Yet other

scholars posit that sound stakeholder management helps to decrease transaction costs

Beyond Bounded Instrumentality in Corporate Sustainability

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(Williamson, 1981) and thus enhances corporate efficiency (Jones, 1995).

All these conceptual approaches have in common that they conceptualize corporate environ-

mental and social strategies as a means to enhance financial outcomes. Not all companies will

benefit from proactive environmental and social behavior and firms should choose strategically

which environmental and/or social strategies they pursue or abandon (Aragón-Correa and Rubio-

López, 2007; Aragón-Correa and Sharma, 2003; Husted and de Jesus Salazar, 2006). Due to this

communality these approaches are often referred to as the business case for sustainability

(Barnett, 2007; Burke and Logsdon, 1996; Dyllick and Hockerts, 2002; Epstein and Roy, 2003;

Reinhardt, 2000a; Salzmann et al., 2005).

Measurement Approaches

Another stream in the literature on corporate sustainability has focused more on the measure-

ment of corporate sustainability performance. In this context we distinguish between three main

groups: Scholars seeking to correct existing measures of economic outcomes by taking into

account external environmental and/or social effects, measures of corporate eco- and/or social

efficiency, and multidimensional measures of corporate sustainability performance.

Correcting for externalities. From the viewpoint of sustainable development it is argued

that companies should take into account the full environmental and social costs of the impacts

they cause (Crouch, 2006). From this perspective, a company only contributes to sustainability,

if the benefits exceed the sum of internal and external costs (Reinhardt, 2000b). Corporate

economic performance is adjusted for external environmental and social costs caused by the

company’s economic activity (Atkinson, 2000; Huizing and Dekker, 1992). These approaches

require that the damage associated with the use of environmental and social resources can be

monetarized. Monetarizing environmental and social external effects is still heavily disputed and

Beyond Bounded Instrumentality in Corporate Sustainability

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has proven problematic for their practical use in management (Herbohn, 2005; Tol, 2005).

Efficiency approaches. Other scholars propose to measure corporate sustainability in terms

of efficiency. For this purpose the value that is created by an economic activity is related to the

environmental and/or social burden that is associated with it. At the corporate level the notion of

eco-efficiency has gained considerable attention over the last 15 years (DeSimone and Popoff,

1998; Schmidheiny, 1992). Proponents of eco-efficiency posit that companies contribute to sus-

tainable development when they generate more value per unit of environmental or social burden.

However, critics point to the rebound-effect: Gains in eco-efficiency can be over-compensated

by growth so that overall more environmental and/or social harm is caused (Berkhout et al.,

2000; Dyllick and Hockerts, 2002).

Multidimensional approaches. As sustainable development is a multi-faceted concept

comprising numerous economic, environmental and social aspects, many scholars have focused

on multidimensional or composite measures of corporate sustainability (Clarkson, 1995;

Gladwin et al., 1995b; Ruf et al., 1998). When multidimensional measures are aggregated into

one indicator there occurs the problem of weighting the different aspects of corporate

sustainability (Figge and Hahn, 2004b). Aggregation can either be based on monetarization, on

socio-political or socioeconomic preferences or on natural sciences (Schaltegger and Burritt,

2000). Moreover, critics object that multidimensional approaches are unsuitable for corporate

decision making as they induce agency loss and undermine the accountability of managers

(Jensen, 2001).

Empirical Studies on Corporate Sustainability Performance

There is voluminous empirical research on the relationship between corporate environmental

or social performance and corporate financial performance (Margolis and Walsh, 2003; Orlitzky

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et al., 2003). Many of these studies try to establish empirical evidence for the business case for

sustainability (Barnett, 2007; Peloza, 2009). The vast body of literature in this field has,

however, produced mixed evidence with different studies proposing a negative (Griffin and

Mahon, 1997), neutral (McWilliams and Siegel, 2000) or positive relationship (Orlitzky et al.,

2003) of corporate environmental and/or social performance with financial performance. Empiri-

cal studies have been criticized for lacking theoretical foundation (Ullmann, 1985) and for

seeking categorical instead of contingent answers to the question if corporate sustainability pays

off (Barnett, 2007; Griffin and Mahon, 1997; Rowley and Berman, 2000).

In the context of this paper it is particularly interesting to address the direction of the

analysis. This shows the underlying notion of instrumentality, i.e. whether the analysis intends to

show if social and/or environmental outcomes drive financial performance (financial per-

formance as the dependent variable) or the effect of financial performance on corporate social

and/or environmental performance (social and/or environmental performance as the dependent

variable). Margolis and Walsh (2003) find that only 22 out of 127 studies (17%) used social

outcomes as the dependent variable. Thus, the prime concern of the majority of empirical studies

is to establish whether “a one-dollar investment in social initiatives returns more or less than one

dollar in benefit to the shareholder” (Barnett, 2007, p. 794).

Appraising Existing Approaches in Research on Corporate Sustainability

In the following we appraise these existing approaches in research on corporate sustainability

against the three principles of instrumental finality, teleological integration and practicability de-

fined above. This leads us to identify a bounded instrumentality of the existing research.

Instrumental finality. The principle of instrumental finality as defined above requires that

research on corporate sustainability explicates its teleological reference. As sustainable develop-

Beyond Bounded Instrumentality in Corporate Sustainability

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ment is an instrumental concept, any concept of corporate sustainability should be clear on

whose needs it refers to (target stakeholders) and whose development should be sustained

(organizational vs. societal target level).

The conceptual approaches discussed above refer mainly to the organization as the target

level and often have a narrow focus on shareholders as the ultimate target stakeholders of

corporate sustainability. Other stakeholders’ needs are only considered to the degree to which

this eventually enhances financial outcomes. Thus, the vast majority of conceptual approaches

relate corporate sustainability to profitability and long-term survival of the firm as an individual

organization from a shareholder point of view. This is clearly illustrated by scholars who define

corporate sustainability “as a business approach that creates long-term shareholder value by

embracing opportunities and managing risk from three dimensions: economic, environmental

and social dimensions” (Lo and Sheu, 2007, p. 346).

Measurement approaches provide a more diverse picture with respect to the principle of

instrumental finality. Approaches that correct for externalities adopt a societal level notion of

sustainable development. At the same time, they establish a clear instrumentality as the need to

preserve environmental and social resources is based on the services these resources provide to

society (Atkinson, 2000; Reinhardt, 2000b). Efficiency approaches do not establish explicit

instrumental relations between environmental, social and economic aspects. However, concep-

tually most of these approaches are based on the win-win paradigm in that they want companies

“creating more value with less impact” (WBCSD, 2000). Therefore, efficiency approaches tend

to refer to the sustainability of the individual firm as their instrumental finality. The instrumenta-

lity of most multidimensional approaches remains unclear at best. Many of these approaches,

however, posit that environmental and social aspects should be regarded as an end in their own.

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As can be seen above, empirical studies on corporate sustainability performance have a

clearly established instrumentality by mostly referring to financial performance as a dependent

variable. Only a minority of the empirical studies use environmental and social performance as a

dependent variable. Environmental and social aspects are only considered as means to enhance

the financial success of the firm as an individual organization.

Teleological integration. The principle of teleological integration has been defined above as

the need to integrate environmental, social, economic aspects according to their specific

relevance for achieving sustainable development.

With most of the conceptual approaches to corporate sustainability environmental and social

aspects are subjacent to economic outcomes. Consequently, environmental and social concerns

are only taken into account to the degree to which they contribute to superior financial outcomes.

Environmental and social aspects will be discarded as soon as they are in conflict with the

dominant profitability target (Aragón-Correa and Rubio-López, 2007; Epstein and Roy, 2003)

and trade-offs are only considered with regard to the question under which conditions it pays off

for companies to commit to proactive environmental and social business practices (Barnett,

2007; Reinhardt, 1999; Rowley and Berman, 2000). Environmental and social concerns

(Aguilera et al., 2007; Kallio and Nordberg, 2006) or a natural or societal case for corporate

sustainability (Dyllick and Hockerts, 2002; Young and Tilley, 2006), i.e. the sacrifice of some

economic outcome in support of enhanced environmental or social outcomes, are virtually absent

from this literature. Consequently, the integration and weight of environmental and social aspects

do not follow from their relevance for sustainable development but solely from their relevance

and contribution to economic efficiency in terms of return on capital. Thus, the vast majority of

the conceptual approaches on corporate sustainability do not meet the principle of teleological

Beyond Bounded Instrumentality in Corporate Sustainability

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integration.

Measurement approaches correcting for externalities allow a teleological integration of

environmental, social and economic aspects. All environmental and social effects of business ac-

tivities are considered and valued at their full social cost irrespective of whether environmental

or social issues contribute to enhanced financial outcomes (Atkinson, 2000; Huizing and Dekker,

1992). Rather, the weights of the different aspects depend on their relative harmfulness to

society. In contrast, efficiency approaches and multidimensional approaches do not provide clear

guidance on integrating different environmental and social aspects with economic targets.

Rather, they mostly address different aspects separately so that corporate sustainability is repre-

sented in some mosaic or patchwork style, e.g. when eco-efficiency is expressed in different

separate aspects like waste efficiency or energy efficiency. As a consequence, trade-offs between

different aspects of corporate sustainability cannot be addressed. Likewise, many

multidimensional approaches do not integrate the different aspects into a composite measure

(Clarkson, 1995). With those that do provide composite measures integration is often based on

scoring models that are value-laden and establish some normative weighting between different

aspects that is not derived from the teleological level (Ruf et al., 1998; Schepers and Sethi,

2003).

Practicability. The principle of practicability has been defined above as the need to inform

and guide managers on more sustainable corporate policies and practices.

There is a growing practitioner literature that provides guidance on strategies which are based

on conceptual approaches that favor the business case for sustainability. Many of these

publications propose tools for developing so-called win-win strategies (Aragón-Correa and

Rubio-López, 2007; Burke and Logsdon, 1996; Epstein and Roy, 2001, 2003; Maxwell et al.,

Beyond Bounded Instrumentality in Corporate Sustainability

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1997; Peloza, 2009) or provide guidance on how to translate environmental and social aspects

into business terms, such as cost savings (Epstein and Roy, 1997; Florida, 1996) or competitive

advantages (Reinhardt, 1998). However, practical approaches have been criticized for remaining

within the economic growth paradigm and falling short of a integrating environmental and social

aspects as ends in themselves (Prasad and Elmes, 2005). Overall, it seems fair to assume that

conceptual approaches that focus on the business case for sustainability have some practical

impact in corporate decision making.

The practicability of measurement approaches is mixed. Approaches that correct for exter-

nalities suffer severely from the ambiguity and the lack of estimates of full costs of environmen-

tal and social impacts (Herbohn, 2005; Tol, 2005). Moreover, managers are neither used nor

trained to gauge social costs and externalities. The overall practicability of these approaches is

thus rather low. In contrast, the corporate sector seems to be quite receptive to efficiency

approaches. In particular, the notion of eco-efficiency has developed into one of the most

prominent catchphrases in the corporate sustainability management arena (DeSimone and

Popoff, 1998; WBCSD, 2000). At the same time efficiency approaches provide little guidance on

solving trade-offs between different aspects of corporate sustainability so that the practicability

of efficiency approaches is mixed. Multidimensional measures are quite often used in corporate

environmental, social and sustainability reporting (Kolk, 2008). Given their complex and ambi-

guous nature it has been doubted that multidimensional measures are suitable to play a major

role in corporate decision making (Jensen, 2001). However, several studies find that environ-

mental and social aspects influence managerial perceptions and decision making at the individual

level (Banerjee, 2001; Fineman, 1996). Overall, we estimate that multidimensional approaches

have a medium level of practicability.

Beyond Bounded Instrumentality in Corporate Sustainability

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Empirical studies on corporate sustainability performance are not primarily designed to

inform and guide decision making at the corporate level. In addition, most empirical studies have

been criticized to seek for categorical rather than contingent answers to the question whether

proactive environmental and social business practices pay off so that their overall practicability

remains low.

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Insert Table 1 about here

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Table 1 summarizes the findings and illustrates that none of the existing approaches meets all

the principles for a sound conceptualization of instrumentality in corporate sustainability.

Bounded Instrumentality

As defined above, it is at the core of corporate sustainability that companies should pursue

environmental, social and economic goals alike in order to achieve long-term prosperity of the

firm (organizational target level) or to contribute to the long-term prosperity of society and

humankind (societal target level). This means that environmental, social, and economic targets

are instrumental for corporate sustainability. Environmental, social and economic aspects are all

means to the end of sustainable development and should thus be integrated depending on their

relevance for corporate sustainability. Trade-offs between environmental, social and economic

aspects must be solved without any systematic predominance of any of the dimensions of

sustainability. Figure 1a illustrates such a teleological integration of environmental, social, and

economic aspects.

Our analysis above shows that most of the existing approaches in the field fall short of

measuring up to this core notion of corporate sustainability. Some of the approaches discussed

Beyond Bounded Instrumentality in Corporate Sustainability

20

do not establish any clear instrumentality (multidimensional approaches). And most of the

approaches that do establish some kind of instrumentality have a narrow focus on profitability.

As a consequence the integration of environmental, social, and economic aspects is biased

towards economic performance. We refer to this deficiency as bounded instrumentality (see

Figure 1b). It is bounded in two respects: First, it refers to the conventional notion of profitability

in terms of return on economic capital in order to operationalize instrumental finality of

corporate sustainability. Consequently and second, it establishes a systematic a priori economic

predominance in the integration of economic, environmental, and social aspects.

--------------------------------------------

Insert Figure 1 about here

--------------------------------------------

The conceptual misspecification that goes along with the bounded instrumentality of most of

the approaches to corporate sustainability results in environmental and social aspects being

subjacent to economic aspects. Corporate sustainability is subject to driving profitability and en-

vironmental and social aspects that are in conflict with enhanced financial performance are dis-

carded. Unlike the assertion of many proponents of the business case (Epstein and Roy, 2003;

Reinhardt, 2000a; Romero Castro and Piñeiro Chousa, 2006), this does not represent an

integration of sustainability into corporate management, rather it boils down to nothing more

than business as usual (Kallio and Nordberg, 2006).

This bounded instrumentality leads to misguided signals for sustainable corporate decisions

making because its inherent focus on win-win cases does not guarantee that the most sustainable

strategy options are identified. Rather, this can result in situations where options that are overall

more sustainable are discarded in favor of less sustainable options that provide some financial

Beyond Bounded Instrumentality in Corporate Sustainability

21

benefit to the firm.

--------------------------------------------

Insert Figure 2 about here

--------------------------------------------

Figure 2 provides a schematic picture of different possible performance trends of a sample

company. Let 0 denote the status quo. Any improvements in economic performance reside in

quadrants III and IV while improvements of environmental and/or social performance will be

found in fields I and IV. Obviously, the win-win solution favored by the business case is situated

in quadrant IV (e.g. performance trends A and A*) whereas quadrant II clearly defines

developments towards less sustainability. Fields I and III represent situations in which there is a

trade-off between environmental and/or social performance and economic performance.

Consider a case where a company has to choose between strategies B and C. Bounded

instrumentality will always favor strategy C over strategy B as C entails an improvement in

profitability whereas B does not. This is despite the facts that (1) the loss in environmental

and/or social performance in case C is higher than the gain in economic performance (line 0c >

line cC) and (2) the improvement in environmental and/social performance with strategy B

outweighs the slight loss in economic performance (line 0b > line bB). In other words, there is a

positive net sustainability effect with strategy B and a net negative effect with strategy C.

As another case to exemplify misguidance of bounded instrumentality consider a situation in

which a company will have to choose between strategies A* and B. Note that strategy A* is a

win-win strategy which will thus be preferred by current approaches. However, from a

sustainability viewpoint one may argue that strategy B should be preferred to strategy A* as the

net improvement with strategy B might outweigh the overall improvement with strategy A* (line

Beyond Bounded Instrumentality in Corporate Sustainability

22

0b – line bB > line 0a’ + line 0a”).

Overall, and as a result of our analysis we believe that the dominance of the conventional

notion of profitability in terms of return on economic capital is not compatible with the concept

of corporate sustainability. This holds both in conceptual and practical terms. As a consequence,

conceptions of corporate sustainability should not be built on the conventional notion of

profitability. In the next section we propose a more inclusive notion of corporate profitability

that is more compatible with the concept of sustainable development.

TOWARD AN INCLUSIVE NOTION OF CORPORATE PROFITABILITY

Shrivastava (1995) calls for rethinking the basic concepts of organizations like economic

performance and profitability. We heed this call by redefining the notion of corporate profita-

bility in the light of sustainable development or “as if sustainability matters” (Gladwin et al.,

1995a, p. 896). As shown above, the use of conventional notion of profitability in terms of (risk-

adjusted) return on economic capital as a conceptual basis for corporate sustainability leads to

bounded instrumentality. In the following, we propose an inclusive notion of corporate

profitability that overcomes bounded instrumentality by establishing a clear instrumental finality,

allowing teleological integration and avoiding practical misguidance.

Conceptual foundations. Already in the late 19th century David I. Green has proposed to apply

opportunity cost thinking to the management and valuation of natural resources:

But, when we once recognize the sacrifice of opportunity as an element in the

cost of production, we find that the principle bas a very wide application. Not only

time and strength, but commodities, capital, and many of the free gifts of nature,

such as mineral deposits and the use of fruitful land, must be economized if we are

to act reasonably. Before devoting any one of these resources to a particular use, we

must consider the other uses from which it will be withheld by our action; and the

most advantageous opportunity which we deliberately forego constitutes a sacrifice

Beyond Bounded Instrumentality in Corporate Sustainability

23

for which we must expect at least an equivalent return (Green, 1894: 224).

Recently, this proposition has been adopted in approaches to natural resource validation

(Lawrence and Morell, 1995; Lovett, 2001) and to corporate sustainability (Figge, 2001; Figge

and Hahn, 2004a, 2005). We build on this research to develop our inclusive notion of corporate

profitability. Opportunity costs have been used in financial economics for a long time in order to

determine the cost of economic capital (Huang, 1933; Souter, 1932). Opportunity costs represent

the foregone return that could have been created by an alternative use of capital. It is standard

practice in financial economics to determine the opportunity cost of capital by the market yield

of an investment with a similar risk (Feibel, 2003; Modigliani and Miller, 1958). In financial

management, based on the notion of opportunity cost a number of so-called value-based

management and measurement approaches such as shareholder value (Rappaport, 1986) or

Economic Value Added (Stewart, 1991) have been developed.

From this viewpoint a company creates economic value whenever its return on capital

exceeds the risk-adjusted market return, i.e. the opportunity cost. Corporate performance and

profitability is thus expressed as the excess capital efficiency:

Economic value created =

Amount of capital usedCompany · (Capital efficiencyCompany – Capital efficiencyMarket)

From this point of view the use of capital in a company is profitable and value-creating if it

yields more return than in other companies, i.e. on the market. In other words, only companies

that use economic capital more efficiently than the market create economic value. The capital

efficiency of the market thus determines the opportunity cost of capital and the hurdle rate a

company has to reach to justify the use of capital. This conventional, value-based approach to

corporate profitability represents the current mainstream in financial management.

Opportunity cost-based assessment of corporate sustainability. As shown above, this

Beyond Bounded Instrumentality in Corporate Sustainability

24

conventional notion of profitability is not compatible with the notion of corporate sustainability.

However, we argue that following the example of financial management and assessing

environmental and corporate aspects via opportunity costs provides a sound foundation to

reconceptualize the notion of corporate profitability as if sustainability matters.

For this purpose we fall back on the capital approach to sustainability and apply it to the firm

level (Reinhardt, 2000b). Following the capital approach sustainable development depends on

the efficient use and the preservation of critical stocks of economic, natural and social capital. At

the same time, companies depend on the use of different forms of economic, natural and social

resources. While the conventional notion of profitability acts as if only economic capital

mattered, from a sustainability perspective the creation of profits depends on the use of an entire

bundle of environmental, social and economic resources. To assess corporate profitability and in

strong analogy to standard practice in financial management, we propose to determine the oppor-

tunity cost of economic, environmental, and social capital, rather than addressing only economic

capital. Economic value is created when a company exceeds the market return on economic

capital (Feibel, 2003). Analogously environmental and social resources create value when they

are used more efficiently than the market on average. We can express this excess return or value

contribution for each form of capital based on opportunity cost thinking as follows:

Value contributioni =

Resource useiCompany · (Resource efficiencyi

Company – Resource efficiencyiMarket),

with capital i being any form of economic, natural, or social capital. In principle, such an

assessment can be done for every form of natural and social capital that can be quantified. As

soon as the use of a resource in a company exceeds its opportunity costs, this resource is being

used profitably. The value contribution provides a monetary measure of the excess profit for

Beyond Bounded Instrumentality in Corporate Sustainability

25

each aspect that is considered.

Extending opportunity cost thinking to other resources next to economic capital represents

the first step towards a more inclusive notion of corporate profitability. However, as companies

depend on a set of different forms of capital, profitability should integrate the use of the entire

bundle of different forms of capital to create profits. This brings up the question of how the

different resources relate to each other. As stated above, in financial management the capital

efficiency of the market represents the hurdle rate that a company has to reach to justify the use

of capital. This also holds for the opportunity cost of environmental and social resources so that

the market efficiency of the different resources defines the minimum return rate that has to be

achieved in order to justify the use of environmental and social resources. The question whether

a resource is used in a value-creating way is therefore defined at the market level. As long as

only one resource is considered, the question of how to integrate different resources is irrelevant

and the respective resource efficiency of the market can be used to assess profitability. As from a

sustainability perspective the entire bundle of resources must be used profitably, the question of

integration becomes relevant. An integrated assessment needs to ascertain the opportunity cost of

a bundle of different resources rather than the opportunity cost of just one resource. As the

opportunity cost of each resource is defined by the respective resource efficiency of the market,

the integration of different resources in an opportunity cost-based assessment depends on the

relation between the market efficiencies of the different resources within a resource bundle.

The market return on a resource, i.e. the resource efficiency of the market, is defined by the

profit the market achieves per resource unit on average. As the different resources are

complements for the creation of profits, the relation between the different resource efficiencies

shows the relation of the different resources within the resource bundle. Consider a situation

Beyond Bounded Instrumentality in Corporate Sustainability

26

where the market on average generates 8% return on capital (capital efficiency of 8%) and at the

same time € 2 of profit per ton of CO2-emissions. In other words, to create €1 of profits the

market requires € 12.50 of economic capital and 0.5 tons of CO2-emissions. Overall, let the

capital use in the market be € 12.5 million and the overall CO2-emissions 500,000 tons, which

corresponds to an overall profit of the market of €1 million.

MarketMarket

Market

MarketMarket

2 Market2

Profit €1,000,000Capital efficiency 8%

Capital use €12,500,000Profit €1,000,000 €2

CO -efficiencyCO -emissions 500,000t 1t

In order to determine the relation between the use of economic capital and CO2-emissions in

the market we can express the CO2-efficiency of the market as a function of the capital efficiency

of the market.

Market MarketMarket

2 Market Market2

Profit Capital use €12,500,000 €2CO -efficiency 8%

Capital use CO -emissions 500,000t 1t

It is noteworthy that the relation between the CO2-efficiency of the market and the capital

efficiency of the market is determined by the relative proportion of the use of economic capital

and CO2 in the market. This means that the market efficiency of any resource can be expressed in

relation to the capital efficiency of the market using the ratio of that resource relative to capital.

As a consequence and because the market efficiency of a resource determines the opportunity

cost of a resource, the latter can be expressed as the product of the capital efficiency of the

market and relative proportion of a resources use relative to the capital use on the market. In

other words, the ratio between the amount of a resource and the amount of capital used by the

market represents the weight of this resource relative to the capital use at the market level and

thus the relative weight of the different resources used in the market. This also means that the

higher the market efficiency of a resource the higher the weight of this resource in the resource

Beyond Bounded Instrumentality in Corporate Sustainability

27

bundle at the market level (Figge and Hahn, 2004b). The opportunity cost of any resource i can

thus be expressed as a function of its relative weight in the resource bundle of the market. The

opportunity cost of a resource i depends on the amount of the resource i used in the company, a

constant (capital efficiency of the market) and the relative proportion of resource i compared to

the capital use at the market level which determines the weight of the resource.

MarketCompany Company Market

Market

Company Company

Value contribution of resource

Capital useResource use Resource efficiency Capital efficiency

Resource use

Profit Resource use Capital efficien

i

i ii

i

Market

MarketMarket

Capital usecy

Resource use

Opportunity costi

i

An inclusive notion of profitability needs to take into account the entire bundle of resources

that is required to make a profit. To integrate the use of several different forms of capital the

opportunity cost of the bundle of different forms of capital used needs to be taken into account.

As could be seen above, the relation between and weight of different resources is determined by

the relative proportion of their use at the market level. Recall that the value contribution

discussed above expresses the excess profit that is obtained after the opportunity cost of the use

of a resource is taken into account but that it only reflects the use of one resource and implicitly

assumes that the entire profit is created through the use of this very resource.1 For an integrated

assessment of the profitability of the use of an entire bundle of resources it is thus not sufficient

to simply sum up the different value contributions as this would overestimate the profit by a

factor of n, i.e. the number of resources considered. To prevent this, the sum of all value

contributions needs to be divided by n. This ensures that the different forms of capital are taken

1 It is noteworthy that the conventional notion of economic value creation is based on this assumption as it only

takes into account economic capital in the assessment of corporate profitability.

Beyond Bounded Instrumentality in Corporate Sustainability

28

into account as a bundle of complements and that the opportunity cost of this bundle of resources

is not overestimated by a factor of n.

1

1

Company Company Market1

1

Company Company Ma1

Sustainable value Value contribution

Resource use Resource efficiency Resource efficiency

Resource use Resource efficiency Capital efficiency

n

ini

n

i i ini

i in

Market

rketMarket

1

MarketCompany Company Market1

Market1

Capital use

Resource use

Capital useProfit Resource use Capital efficiency

Resource use

Opportunity cost of resource bundle

n

i i

n

ini i

The resulting indicator of excess profitability has been referred to as sustainable value (Figge

and Hahn, 2005). It represents an integrated measure that shows the profitability of the use of all

forms of capital in a company. A positive (negative) sustainable value indicates how much more

(less) profitable a company uses its bundle of economic, natural, and social capital in comparison

to the market on average. In other words, it expresses the excess profitability of a company’s use

of a bundle of different forms of capital. It broadens the application of opportunity cost thinking

to go beyond the narrow focus on economic capital.

With regard to the integration of different resources, it becomes clear that the weight of each

resource within the resource bundle is determined by the relative proportion of its use at the

market level as can be seen from the way the overall opportunity cost of a bundle of resources is

calculated. The logic of the integration thus strictly follows from the relative weight of the

different resources at the market level. In other words, the integration of different resources is

based on the relative importance of a resource for the overall opportunity cost of a resource

bundle.

Consider the following simple example to illustrate the logic of this inclusive notion of

Beyond Bounded Instrumentality in Corporate Sustainability

29

profitability and the underlying integration of different resources. Table 2 shows the performance

data of a sample company and the corresponding market (resource use and resource efficiencies)

with regard to capital use, CO2-emissions, water use and work accidents. The example provides a

mixed picture with regard to the company’s performance relative to the market with some areas

where the company exceeds market efficiency (capital use, CO2-emissions, and work accidents)

and one area of under-performance (water use).

--------------------------------------------

Insert Table 2 about here

--------------------------------------------

Table 3 provides the assessment results for the inclusive profitability of the sample company.

As developed above and shown in Table 3, the weights of each resource in the integrated

assessment is determined by the relative proportion of the use of the resources at the market

level. The overall profitability of the use of the resource bundle in this example follows from the

division of the sum of the value contributions by 4 (to avoid double counting as explained above)

and results in € 7,500, This means that the company achieves € 7,500 more profit than the market

would have achieved with the same set of resources. It is noteworthy that this integration logic

also holds in the case of equivocal cases in which corporate performance provides a mixed

picture of under- and over-performance compared to market performance in different areas.

--------------------------------------------

Insert Table 3 about here

--------------------------------------------

Practical application. In the following, we apply the proposed concept of an inclusive

Beyond Bounded Instrumentality in Corporate Sustainability

30

notion of profitability in two different settings. This illustrates the rationale behind our argument

and demonstrates its feasibility. In the first setting, we analyze the economic and environmental

performance of the four car manufacturing companies BMW, Daihatsu, Renault and GM for the

period of 2001-2005. In this setting, we illustrate that an integrated assessment with our inclusive

notion of profitability captures the sustainability of firm performance more comprehensively

than the conventional, solely capital-focus notion of profitability. In the second setting and using

the example of the car manufacturer DaimlerChrysler, we add more resources to the analysis in

order to demonstrate the feasibility of the approach under more realistic conditions.

In the first setting, capital efficiency (in terms of EBIT from ordinary business activities per

total assets) and CO2-efficiency (in terms of EBIT from ordinary business activities per sum of

direct and indirect CO2-emissions from operations) are used as examples for financial and

environmental performance, respectively. For the sake of simplicity we restrict the example to

these two forms of capital in the first setting. Following the rationale described above the value

contributions for total assets and CO2-emissions are determined. For both indicators, opportunity

cost is defined by the average capital efficiency and CO2-efficiency of the car manufacturing

sector worldwide, respectively. In order to control for short-term fluctuations, sector averages

are determined by the 5-year averages of 16 major car manufacturers based on corporate data on

total assets, EBIT from ordinary operations and total CO2-emissions. To ensure data reliability

and comparability the consistency of the scope and the definition of the data have been checked

and corrected where necessary.

Beyond Bounded Instrumentality in Corporate Sustainability

31

--------------------------------------------

Insert Table 4 about here

--------------------------------------------

Table 4 shows the results of the assessment for four car manufacturers. For instance in the

period between 2001 and 2005 on average, the return on total assets of BMW exceeded the

market efficiency by 2.84% (5.81% – 2.97%). With an overall amount of € 62.09bn of total

assets this results in an economic value contribution of about € 1.76bn. Likewise on average,

BMW created € 2,208 more EBIT per ton of CO2 emitted than the car manufacturing sector

(€ 2,992 per ton of CO2 – € 783 per ton of CO2), which results in a CO2-value contribution of

about € 2.67bn (1,209,115 tons of CO2-emissions · € 2,208 per ton of CO2). It can be seen that

the company yields both an above sector average capital efficiency and an above sector average

CO2-efficiency. Put differently, in the period between 2001 and 2005 BMW earned its

opportunity costs for both economic capital and CO2-emissions und thus provided positive value

contributions for both aspects. The overall excess profitability taking into account economic

capital and CO2-emissions of BMW (compared to the car manufacturing sector) was about

€ 2.22bn.

The four companies cover four distinct cases. While BMW covers opportunity costs in both

performance areas, GM shows strong underperformance in both economic and environmental

terms. Obviously, Daihatsu and Renault are the most interesting cases. While Daihatsu earns its

economic opportunity cost Renault falls short of doing so. From a conventional perspective,

including the business case for sustainability, Daihatsu would thus be preferred over Renault.

However, Renault achieves clearly higher levels of CO2-efficiency compared to the other car

manufacturers while Daihatsu ranges below sector-average in that respect. This effect is that

Beyond Bounded Instrumentality in Corporate Sustainability

32

pronounced that overall, i.e. when profitability takes into account both, capital efficiency and

CO2-efficiency, Renault yields an above sector-average performance while Daihatsu slightly

falls short of doing so.

This application clearly shows that using our notion of inclusive profitability, economic and

environmental aspects are integrated into an aggregated profitability measure without

establishing an a priori predominance of environmental or economic aspects. In other words and

unlike the business case, environmental aspects (here CO2-performance) are not reduced to their

contribution to enhancing return on economic capital.

In the second setting we analyze the performance of the car-maker DaimlerChrysler. Like in

the first setting this analysis covers the period between 2001 and 2005 in order to avoid the effect

of short term fluctuations. However, this setting includes the use of overall nine different

resources by the company and assesses the profitability of the use of this resource bundle by

DaimlerChrysler in comparison to the car manufacturing sector. The respective resource

efficiencies are defined as the ratio between the EBIT from ordinary operations and the amount

of the respective resource used. Table 5 shows the results of the assessment.

--------------------------------------------

Insert Table 5 about here

--------------------------------------------

Two aspects of this application are particularly noteworthy. First, this application shows that

an opportunity cost-based assessment of corporate sustainability is feasible for a larger set of

different economic, environmental and social aspects. Following the opportunity cost-based logic

of the integration developed above, different aspects of different magnitude and direction can be

taken into account in order to come up with an aggregated assessment of corporate profitability

Beyond Bounded Instrumentality in Corporate Sustainability

33

that includes a set of resources rather than just economic capital. Second, the application to the

case of DaimlerChrysler reveals that a conventional assessment based on capital efficiency only

does not capture the overall positive sustainability performance of the company. The capital

efficiency of DaimlerChrysler resides below the market efficiency which results in a negative

economic value of -€ 0.70bn. Such a conventional profitability assessment entirely ignores the

fact that the overall excess profitability of DaimlerChrysler is positive as the company achieves

€ 1.12bn more profit compared to the market when the entire bundle of nine different resources

is taken into account in the assessment. This clearly demonstrates the difference between the

conventional notion of profitability and our more inclusive approach that includes economic

capital alongside other resources rather than considering economic capital as the only resource

that is relevant for assessing corporate profitability.

Toward an inclusive notion of corporate profitability. In its core, the proposed inclusive

notion of corporate profitability is characterized by going beyond economic efficiency as the

instrumental focus. Rather, it readjusts profitability to address all different forms of capital –

economic, environmental and social – without any systematic a priori predominance of any of

the capital forms. The validity of the proposed notion of profitability becomes particularly

evident by appraising it against the three conceptual principles of corporate sustainability

identified above.

With regard to instrumental finality the inclusive notion of profitability goes beyond the

organizational target level as it links the use of environmental, social, and economic capital at the

corporate level to the use at the market level. Eventually, this shows an individual firm’s

contribution to enhancing the efficient use of environmental, social, economic capital at the

market level. For this purpose, it considers environmental, social, and economic aspects irrespec-

Beyond Bounded Instrumentality in Corporate Sustainability

34

tive of if they pay-off for the individual firm in terms of enhanced financial outcomes. By doing

so, it establishes an explicit instrumentality as environmental, social, and economic aspects are

instrumental to enhance the overall excess return on the bundle of different forms of capital used.

One of the main characteristics of our notion of inclusive profitability is that it provides a

teleological integration of environmental, social, and economic aspects. Unlike approaches fol-

lowing the paradigm of the business case, it does not assess environmental and social aspects

through the lens of an enhanced return on economic capital. As shown above and based on the

notion of opportunity costs, it integrates environmental, social and economic aspects according

to their contribution to value creation. The logic and weights for the integration are derived from

the teleology that the different form of capital should be used as least as efficiently as the market

on average in order to contribute to more sustainability through a more efficient use of

environmental, social and economic forms of capital. Opportunity costs and the efficiency of use

of resources at the market level serve as the teleological criterion for the integration of different

forms of capital in order to assess the profitability of a company from the perspective of

sustainable development.

Furthermore, as shown in the practical examples, trade-off situations between different

aspects of corporate sustainability can be solved without a systematic subordination of

environmental and social issues under economic outcomes as with the business case paradigm.

This enhances the practicability of the proposed notion of inclusive profitability. With an

inclusive conceptualization of profitability, practical misguidance on trade-off cases in the quest

toward more sustainable corporate practice is avoided. Furthermore, as it is based on the widely

accepted concept of opportunity costs, our notion of inclusive profitability is compatible with

managerial thinking and decision making. Rather than rejecting the orientation of firms on

Beyond Bounded Instrumentality in Corporate Sustainability

35

profitability and efficiency we embrace and further develop the notion of profitability to enable

corporate decision making for more sustainable business practices. At the same time, the

inclusive notion of profitability requires environmental, social and economic aspects to be

quantifiable and data must be available (see discussion of limitations below). While there is

some data that is already available in the market today – as could be shown by the application to

car manufacturers – these requirements limit the practicability of the approach presented in this

paper.

Overall, we propose a reconceptualized inclusive notion of corporate profitability to help

overcome the bounded instrumentality that impairs current research on corporate sustainability.

In the following section we discuss the main conceptual implications and provide some starting

points for future research.

DISCUSSION AND IMPLICATIONS FOR RESEARCH

Since the early paradigmatic debate that bore strong pleas for adopting sustainable develop-

ment in mainstream management and organization research (Gladwin et al., 1995a; Purser et al.,

1995; Shrivastava, 1995) the field has seen substantial development in terms of quality, quantity

and overall acceptance (Bansal and Gao, 2006). However, skeptical voices express some doubt if

the field has gone beyond legitimizing business as usual (Kallio and Nordberg, 2006; Prasad and

Elmes, 2005; Springett, 2003) and have argued that environmental and social aspects are

virtually absent from much of the research on corporate sustainability (Aguilera et al., 2007;

Kallio and Nordberg, 2006).

We also doubt that corporate sustainability is only assumed at the intersection of the

environmental, social, and economic aspects (Bansal, 2005). The number of conceptual, practical

and empirical articles that try to establish or prove that environmental and/or social pro-active-

Beyond Bounded Instrumentality in Corporate Sustainability

36

ness pays off financially is legion. To the detriment of the notion of sustainable development,

this results in a situation where environmental and social aspects are only integrated to the

degree to which they enhance financial performance – and thus profitability in conventional

business as usual terms. As a consequence, we find that the conventional notion of profitability is

not a suitable foundation for corporate sustainability but leads to bounded instrumentality. Any

notion of corporate sustainability that is rooted in such bounded instrumentality still “tacitly

encourage[s] organizations to behave in ways that ultimately destroy their natural and social life-

support systems” (Gladwin et al., 1995a, p. 896).

The three conceptual principles defined in this paper demonstrate that instrumentality and the

quest for profitability as the fundamental forces that drive business do not have to be rejected in

order to establish and operationalize the notion of corporate sustainability. By doing so, we

follow Shrivastava (1995) who does not argue to abandon basic business principles but calls for

an integration of sustainability into the logic of corporations and a rethinking of basic concepts

like economic performance and profitability. Without sound embodiment in fundamental

business principles, moralistic and prosaic accounts of sustainable profitability (Cramer, 2002;

Soppe, 2004) remain on shaky foundations.

In this paper, we have developed and clarified the notion of instrumentality in corporate

sustainability as well as an inclusive notion of corporate profitability from a conceptual point of

view. In this context, some limitations of the proposed notion of inclusive profitability need to be

addressed. As already mentioned, to be included in the proposed notion of profitability social and

environmental aspects must be quantifiable. This brings up at least two fundamental concerns

with regard to covering corporate sustainability using this approach, namely (a) the treatment of

qualitative sustainability aspects and (b) the quality and suitability of quantitative data. Purely

Beyond Bounded Instrumentality in Corporate Sustainability

37

qualitative aspects of corporate sustainability cannot be covered by the approach proposed in this

paper. We believe that it is very unlikely that there will ever exist a single approach that will

cover all aspects of a complex and multifaceted notion such as sustainable development.

Furthermore, there is no generally accepted set of aspects that determine (corporate)

sustainability. While this certainly limits the scope of the approach presented in this paper we

believe that incorporating a range of quantifiable sustainability aspects under a more inclusive

notion of corporate profitability already represents a major progress compared to a situation

where profitability is based exclusively on one single aspect – economic capital. While we

probably do not know all environmental or social aspects that are scarce, we argue that

environmental and social scarcities should be integrated in any assessment of corporate

sustainability as and when they become known.

With regard to quantitative sustainability aspects, the availability of reliable and comparable

environmental and social corporate data is limited, given that corporate environmental and social

reporting and accounting is still at a juvenile stage and requires more standardization and more

wide spread use (Gray, 2001). This limitation is particularly virulent with regard to social aspects

that are notoriously underrepresented and neglected both in corporate practice and in the

literature (Gladwin et al., 1995b). However, we believe that it will be only through the thorough

use of quantitative sustainability data as well as the ongoing standardization efforts (ISO, 1999)

that the availability and quality of such data will improve over time. In addition to availability,

one may question the suitability of quantitative environmental and social indicators for an

integrated assessment in particular with regard to the compatibility of such measures with

financial performance data. While financial performance data is obviously highly standardized

and accepted, environmental and social performance measurement still lacks behind in terms of

Beyond Bounded Instrumentality in Corporate Sustainability

38

acceptance and use. However, for a conceptual argument as presented in this article it is more

critical that financial, environmental and social measures are conceptually compatible. By

bringing together the capital approach to sustainability and the financial performance assessment,

our inclusive notion of profitability extends the range of different resources that companies

require to generate profits beyond a single focus on economic capital. For measurement purposes

this means that the analysis requires data not just on the amount of economic capital used but

also on the amount of environmental and social resources used. Such physical measures have

been discussed and defined extensively in the fields of environmental and social accounting

(Bennett and James, 1999; Jasch, 2000; Rubenstein, 1994). Conceptually, such quantitative

physical measures of environmental and social performance represent the equivalent information

to financial data on the use of economic capital in standard financial analysis. Hence the

conceptual fit of environmental and social indicators represents less of a limitation to our

approach compared to the actual availability and quality of reliable performance data in the

market today.

A further limitation is related to the aggregation of different environmental, social and

economic aspects into one single indicator as proposed by our inclusive notion of profitability. In

all such integrations information on details is lost. However, we believe that it is important to

provide highly aggregated indicators as multidimensional indicators establish no unanimous

objective function for management (Jensen, 2001). If more detailed information is needed the

indicator proposed in this paper can be broken down into the value contributions of each form of

capital considered.

The development of the inclusive notion of profitability proposed in this paper has some far

reaching implications. First, the argument in this paper ultimately touches upon the objective

Beyond Bounded Instrumentality in Corporate Sustainability

39

function and purpose of the firm. Conventional wisdom suggests, that firms should ultimately

maximize shareholder wealth under a given market and regulatory framework. The responsibility

of a firm in such a setting is thus reduced to maximizing shareholder return while respecting the

law (Friedman, 1970). In this context it is argued that managing capital use via opportunity cost

thinking will increase capital efficiency in the market over time (Nielsen, 1976). From this

dynamic point of view, the argument goes that companies that fail to earn their opportunity costs

of capital will be driven out of the market because investors withdraw their capital. Such

companies will eventually cease to exist and be replaced by more efficient companies. Our

inclusive notion of profitability adopts this dynamic logic and extends it to cover environmental

and social aspects next to economic capital. We argue that in order to provide positive

contributions to sustainable development a company should maximize the return on the bundle

of different forms of capital it employs. Analogously to present financial market dynamics,

opportunity costs of the different forms of capital thus provide the key to allocating these forms

of capital efficiently. From this perspective, the objective function of the firm is not restricted to

shareholder value maximization but is extended to sustainable value maximization, i.e. the

maximization of the return on a bundle of different forms of capital. Hence, the allocation of this

bundle of different forms of capital according to the opportunity cost logic will increase overall

efficiency of the different forms of capital at the market level over time. Companies that fail to

cover the opportunity cost of the bundle of different forms of capital they use will be crowded

out and replaced by more efficient ones. Following this logic, there might exist cases where

companies deliberately forego some return on economic capital in favor of greater gains in

environmental or social efficiency. What will be considered irrational from the traditional

definition of profitability turns out rational from an inclusive notion of profitability.

Beyond Bounded Instrumentality in Corporate Sustainability

40

Today market dynamics and incentive systems still favor a narrow focus on return on

economic capital. Our paper offers a conceptual proposition for a more inclusive notion of profi-

tability that provides a suitable foundation for corporate sustainability. The implementation of

such a notion will most probably require different market and incentive structures. This brings up

the question how companies and markets can move from a biased and narrow notion of

profitability towards a more inclusive notion that is more compatible with sustainability. Such a

change of market and incentive structures corresponds to an alteration of currently dominant

institutions. Such institutions – partly codified through regulation – stabilize, frame and constrain

corporate behavior, these institutions are not imposing restrictions that actors have to comply

with passively. Rather actors have the possibility to influence, shape and modify institutional

settings and logics along their interests through institutional work (Lawrence and Suddaby,

2006) and institutional entrepreneurship (Garud et al., 2007; Maguire et al., 2004). Especially

actors that control key strategic resources or other forms of power have significant impacts on

the evolution of institutions (Greenwood et al., 2002; Lawrence and Suddaby, 2006).

As Phillips et al. (2004) argue, institutions are shaped and enacted through discourses. Actors

can actively participate in such discourses to influence “the nature and structure of discourses

and, in turn, affect […] the institutions that are supported by those discourses” (2004, p. 648) in a

self-interested way for instance through technical and market leadership or lobbying for

regulatory change. For instance, Ahmadjian and Robinson (2001) and Fiss and Zajac (2004,

2006) provide empirical accounts of successful institutional change through corporate discursive

action in the context of deinstitutionalizing hiring practices in Japan and institutionalizing

shareholder value-oriented governance modes in Germany against the more stakeholder-oriented

traditional German governance model, respectively.

Beyond Bounded Instrumentality in Corporate Sustainability

41

Different actors may have an interest to influence existing market institutions towards the

adoption of a more inclusive notion of profitability. From a public welfare perspective, state

regulators should have an interest in an efficient use of economic, environmental and social

resources in our societies. Hence, regulators may try to influence and alter market institutions to

go beyond a mere focus on traditional capital efficiency and move towards a more inclusive

notion of profitability. The role of regulators for a shift of institutions is particularly relevant due

to their formal authority (Phillips et al., 2004). Given the increasing importance of the

sustainability discourse for companies we may also expect that especially companies with a

proactive sustainability positioning will adopt a more inclusive notion of profitability to

communicate and demonstrate their sustainability performance. Companies that perform well

with regard to our inclusive notion of profitability may have a particular interest to work towards

establishing this notion of profitability in their institutional field in order to gain and maintain

legitimacy. This will enhance the diffusion of such a novel approach within industries and

institutional fields, especially if these proactive companies are industry leaders (as can be

observed in the car industry with industry leaders such as BMW or Toyota). A similar

enhancement of a shift towards a more inclusive notion of profitability can be expected if actors

with high legitimacy, power or centrality such as NGOs or professional associations participate

in a discourse towards a more inclusive notion of profitability with favorable and supportive

statements and recommendations (Greenwood et al., 2002; Phillips et al., 2004). Finally, the

effectiveness of such discourses toward altering institutions depends on their consistency and

compatibility with already existing and well-established institutions (Phillips et al., 2004). In this

respect, the conceptual and methodological proximity of our inclusive notion of profitability with

the well-established and strongly institutionalized notion of opportunity cost-based performance

Beyond Bounded Instrumentality in Corporate Sustainability

42

assessment in financial management may be beneficial.

Obviously, an institutional change obviously requires time, and there is no guarantee that a

more inclusive notion of corporate profitability will eventually replace the traditional notion.

This will depend on numerous factors as well as initiatives of different actors and/or exogenous

events. We may see for example situations where companies use both notions in parallel when

they speak to different audiences. However, even such a coexistence represents a first and

valuable step towards the diffusion of a more inclusive notion of corporate profitability.

While a more detailed discussion of institutional change trajectories for a more inclusive

notion of profitability goes beyond the scope of this paper, there follow some promising avenues

for future research. Future research could address the avenues for institutional entrepreneurship

to establish a more inclusive notion of profitability on markets. In this context, we expect a

pivotal role of companies with a proactive sustainability orientation, NGOs, socially responsible

investors and regulators as actors of change as these actors have an interest to alter market

institutions and regulatory frameworks that favor profitability in terms of return on a set of

different forms of capital rather than just return on economic capital. More at the micro level,

future research could be dedicated to the question of how governance structures within

companies need to be designed in order to orient managerial decision making toward a more

inclusive notion of profitability. In this context, incentive systems for corporate managers as well

as alternative performance measures that are based on an inclusive notion of profitability could

be developed. The latter could contribute to the development of meaningful and practical

measures of corporate sustainability which has been identified as one of the most crucial

challenges for research on corporate sustainability (Bansal, 2002; Gladwin et al., 1995a;

Shrivastava, 1995).

Beyond Bounded Instrumentality in Corporate Sustainability

43

Finally, future research should empirically test and apply the inclusive notion of profitability

proposed in this paper. Used as a dependant variable it could serve as a foundation of developing

empirical research on corporate sustainability performance beyond the bounded instrumentality

of studies that address the question if it pays to be green or socially responsible. In this context,

empirical research should in particular focus on the determinants and influence factors that affect

and drive overall above average returns on environmental, social, and economic forms of capital.

CONCLUSION

In this paper we argue that the conventional notion of profitability and the ubiquitous

business case do not measure up to the notion of sustainable development. However, much of the

current research on corporate sustainability is based on such a narrow focus on financial

performance. This leads to bounded instrumentality that inflicts a systematic a priori

predominance of financial performance over environmental and social organizational outcomes

and thus establishes economic hegemony and bias within the corporate sustainability discourse.

By taking up Gladwin et al.’s (1995a) call for reintegration we redefine corporate profitability as

if sustainability matters.

Conceptually, this paper sheds new light on the principles of corporate sustainability. While

unveiling the inadequacy of the prevailing notion of corporate sustainability as refurbished

business as usual, we do not go from one extreme to the other by sketching out a sustainable

heaven or calling for green utopia and the moral manager. In contrast, we accept that profitability

is one of the very drivers of corporate decision making in a market economy. By falling back on

the well established concept of opportunity costs we develop an inclusive notion of corporate

profitability that incorporates the business imperative for efficiency but broadens the

conventional perspective by integrating environmental, social, and economic forms of capital

Beyond Bounded Instrumentality in Corporate Sustainability

44

without any a priori predominance.

Hence, we do not agree that “only by making the ‘business case’ for social and environ-

mental performance can managers truly integrate social and environmental aspects into their

business strategies” (Epstein and Roy, 2003, p. 80). Rather, we argue that only by rethinking and

broadening the notion of corporate profitability beyond the narrow focus on return on economic

capital can the corporate word truly contribute to sustainable development.

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Beyond Bounded Instrumentality in Corporate Sustainability

51

TABLE 1

Assessment of Existing Approaches on Corporate Sustainability

Principles

Instrumental FinalityTeleological

IntegrationPracticability

Organizational

Target Level

Societal Target

Level

Conceptual Approaches Yes No No Medium

Measurement Approaches

Externalities No Yes Yes Low

Efficiency Yes No No Medium

Multidimensional Unclear Unclear No Medium

Empirical Studies Yes No No Low

TABLE 2

Data for Assessment Example

Amount Resource efficiency Amount Resource efficiency

Capital use € 500,000 12% € 12,500,000 8%

CO2-emissions 20,000 t € 3 per t 500,000 t € 2 per tWater use 250,000 m³ € 0.24 per m³ 2,500,000 m³ € 0.40 per m³Work accidents 120 € 500 per accident 4,000 € 250 per accidentProfit € 60,000 € 1,000,000

Company Market

Beyond Bounded Instrumentality in Corporate Sustainability

52

TABLE 3

Results of Assessment Example

ProfitAmount usedby company

Capitalefficiency

marketRelative weight

Valuecontribution

Capital use € 60,000 - € 500,000 × 8.00% × € 1 : € 1 = € 20,000CO2-emissions € 60,000 - 20,000 t × 8.00% × € 25 : 1 t = € 20,000Water use € 60,000 - 250,000 m³ × 8.00% × € 5 : 1 m³ = -€ 40,000Work accidents € 60,000 - 120 accidents × 8.00% × € 3,125 : 1 accident = € 30,000

Sustainable Value € 7,500

TABLE 4

Performance Assessment of Four Car Manufacturers (Years 2001-2005)

CompanyPerformance

aspectAmount

usedCorporateefficiency

Marketefficiency

Valuecontribution

BMW Total assets € 62.09bn 5.81% 2.97% € 1.76bnCO2-emissions 1,209,115 t € 2,992 per t € 783 per t € 2.67bn

Overall excess profitability € 2.22bn

Daihatsu Total assets € 6.08bn 3.69% 2.97% € 0.04bnCO2-emissions 363,600 t € 626 per t € 783 per t -€ 0.06bn

Overall excess profitability -€ 0.01bn

GM Total assets € 383.28bn 0.42% 2.97% -€ 9.79bnCO2-emissions 12,862,000 t € 111 per t € 783 per t -€ 8.64bn

Overall excess profitability -€ 9.21bn

Renault Total assets € 58.20bn 2.41% 2.97% -€ 0.33bnCO2-emissions 716,124 t € 1,950 per t € 783 per t € 0.84bn

Overall excess profitability € 0.25bn

Beyond Bounded Instrumentality in Corporate Sustainability

53

TABLE 5

Performance Assessment of DaimlerChrysler (Years 2001-2005)

Resource useDaimlerChrysler

Resource efficiencyDaimlerChrysler

Average resourceefficiency car sector

Valuecontribution

Total assets € 190.67bn 2.60% 2.97% -€ 0.70bnCO2-emissions 7,270,507 t € 669 per t € 783 per t -€ 0.83bnNOx-emissions 2,385 t € 2,045,029 per t € 1,369,538 per t € 1.61bnSOx-emissions 546 t € 9,157,512 per t € 2,038,840 per t € 3.89bnVOC-emissions 12,290 t € 400,795 per t € 176,404 per t € 2.76bnWaste generation 680,580 t € 7,253 per t € 3,297 per t € 2.69bnWater use 39,895,177 m³ € 126 per m³ € 118 per m³ € 0.33bnWork accidents 847 € 3,633,479 per acc. € 1,164,971 per acc. € 2.09bnEmployees 369,819 € 13,177 per empl. € 18,042 per empl. -€ 1.80bn

Sustainable Value € 1.12bn

Beyond Bounded Instrumentality in Corporate Sustainability

54

FIGURE 1

Corporate Sustainability and Instrumentality

(a) (b)

Inclusive Profitability Bounded Instrumentality

Economocentric Integration

EnvironmentalAspects

EconomicEfficiency

SocialAspects

Long-termProsperity

Inst

rum

enta

lFi

nalit

y

EconomicAspects

SocialAspects

EnvironmentalAspects

Long-termProsperity

Inst

rum

enta

lFi

nalit

y

Teleological Integration

InclusiveProfitability

Beyond Bounded Instrumentality in Corporate Sustainability

55

FIGURE 2

Practical Misguidance of Bounded Instrumentality

Envi

ronm

enta

l and

/or s

ocia

l per

form

ance

Economic performance

I

II III

IV

+

–

+

–

0

A

B

C

b

c

A*a”

a’